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Income Tax Appellate Tribunal, “A” BENCH : BANGALORE
Before: SHRI N.V. VASUDEVAN & Ms. PADMAVATHY S
IN THE INCOME TAX APPELLATE TRIBUNAL “A” BENCH : BANGALORE BEFORE SHRI N.V. VASUDEVAN, VICE PRESIDENT AND Ms. PADMAVATHY S, ACCOUNTANT MEMBER
IT(TP)A No.224/Bang/2021 Assessment year : 2016-17
Alcon Laboratories (India) Private Ltd., Vs. The Deputy Commissioner 11th Floor, RMZ Azure, of Income Tax, Bellary Road, Hebbal, Circle 1(1)(1), Bangalore – 560 092. Bangalore. PAN: AACCA 3430F APPELLANT RESPONDENT
Appellant by : Shri Percy Pardiwala, Sr. Counsel Respondent by : Shri K. Sankar Ganesh, Jt.CIT(DR)(ITAT), Bengaluru.
Date of hearing : 06.12.2022 Date of Pronouncement : 19.12.2022 O R D E R Per Padmavathy S., Accountant Member This appeal is against the final order of assessment by the AO, National e-Assessment Centre, Delhi u/s. 143(3) r.w.s. 144C(13) dated 31.3.2021 of the Income-tax Act, 1961 [the Act] for the assessment year 2016-17.
The assessee raised the grounds pertaining to the following issues:-
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(i) Ground No.1 & 2 are general. (ii) Ground Nos.3 to 20 relate to adjustment on account of excessive AMP expenditure. (iii)Ground Nos.21 to 30 relate to adjustment in respect of IT support services. (iv) Ground Nos. 31 is regarding disallowance of expenses. (v) Ground Nos.32 & 33 are consequential.
The assessee is a company providing market support and maintenance services to its group companies in relation to the products during and after warranty period. The assessee has entered into an agreement with Alcon Laboratories Inc. dated 1.1.2002 in this regard. The assessee also distributes pharmaceutical products in addition to distribution of Ophthalmic Surgical products. For the AY 2016-17, the assessee filed the return of income on 30.11.2016 declaring a total income of Rs.36,07,89,840. The case was selected for scrutiny under CASS and a notice u/s. 143(2) was duly served on the assessee. Since the assessee had international transactions, the AO made a reference to the TPO for determination of arm’s length price (ALP). Accordingly, the TPO completed the proceedings u/s. 92CA by making an adjustment of Rs.20,07,41,588. The AO passed the draft assessment order incorporating the transfer pricing (TP) adjustment. Besides, the AO also made disallowance of seminars, conventions and sales promotion expenses for an amount of Rs.1,58,88,337. Aggrieved, the assessee filed its objections before the DRP. As per the directions of the DRP the TP adjustment was enhanced to Rs.27,48,87,330. The DRP also confirmed the disallowance made by the AO towards seminars, conventions and sales promotion expenses. The assessee is in appeal
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before the Tribunal against the final assessment order passed pursuant to the directions of the DRP.
Adjustment on account of excessive AMP expenditure - Ground Nos.3 to 20
The TPO observed that the assessee has incurred an expense of Rs.9658 lakhs. The TPO also noticed that the assessee has entered into an agreement with its AE for “distribution and marketing services” with effect from 01.04.2006. The TPO was of the view that incurring of AMP expenses by the assessee is enhancing the value of marketing intangibles of the AE and hence the assessee has to be compensated for the same. The TPO therefore treated the said expenses as a separate international transaction. The assessee submitted before the TPO that the sales and distribution expenses incurred by the assessee is not an international transaction and the incidental benefit accruing to the AE cannot be considered as provision of service. The assessee also submitted that when TNMM is applied analysing individual items of cost may not be appropriate and the bundled approach is relevant. The TPO computed the estimated percentage of AMP expenses incurred by the comparable companies @ 5.94% and accordingly worked out the excess AMP expenses incurred by the assessee as Rs.35,24,45,858 holding the same towards DEMPE function in favour of the AE. The TPO also arrived at the margin to be applied on AMP expenses based on the list of comparables’ median margin of 12.98% and accordingly arrived at the TP adjustment as below:-
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Amount Particulars (Rs. In Lakhs) Excess AMP Incurred for the benefit of the AE 35,24,45,858 Arm’s length Margin (refer para no. 10.4 12.98% above) Arm’s Length Price (35,24,45,858*112.98%) 39.81,93,330 Price received 0 Adjustments 39,81,93,330
Subsequently the adjustment towards AMP expenses is rectified to Rs.18,46,49,177. The DRP gave the directions to the TPO stating that to –
• Reduce 25% of the distributors commission from the AMP expenses. • Verify and rectify the AMP expenses of the comparable companies. • Exclude Killicks Agencies from the comparable list in AMP segment. 6. The TPO passed an order giving effect the median margin was recomputed and 14.43% and the excess AMP expenses incurred treated as incurred for the benefit of AE was revised to Rs.22,61,60,028. Accordingly the TP adjustments towards AMP expenses was computed as Rs.25,87,94,919. Aggrieved by the final order of assessment passed in pursuant to the directions of the DRP the assessee is in appeal before the Tribunal.
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The ld. AR submitted that the issue has been already considered by the coordinate bench of the Tribunal in assessee’s own case for the AYs 2013-14 & 2014-15 in IT(TP)A No.2889/Bang/2017 & 3376/Bang/2018 dated 16.11.2022 as under:-
“2.1 Facts of the issue are that the TPO has discussed in detail in para 9 of his order that AMP is an international transaction. He has also discussed that when the Indian subsidiary is discharging both the distribution and marketing functions, then both the functions need to be benchmarked separately. He has discussed in detail the various clauses of the "Distribution and Marketing Services" agreement with its AE w.e.f. 01/04/2006 to conclude that it is obligatory for the assessee (distributor) to undertake marketing activities on behalf of supplier (its AE). He has also referred that it is operating under the direct supervision and control of its AE. As the assessee has not benchmarked this marketing function, the TPO has benchmarked this transaction separately to determine the ALP of this international transaction. Therefore, the TPO has rightly concluded that the assessee has incurred excessive or non-routine AMP expenditure attributable to DEMPE of marketing intangibles owned by the AE and that such expenditure is a separate international transaction of provision of service. 2.2 Further, the TPO has discussed in para 9.4 of his order that the assessee has not been compensated for the sales and distribution expenditure incurred. It is seen that the TPO has proved that the assessee has incurred far more expenses when it was compared to the companies involved in similar activity. He has mentioned that the assessee has spent substantial portion of money on brand awareness activities. He concluded that this has enhanced the brand image in India. The fact remains that the brand is owned by its AE and hence, the AE has certainly benefitted by the expenses incurred by the assessee. However, the assessee has not been compensated for this. Ld. DRP was in agreement with the arguments of the TPO and found no reason to interfere with the order of the TPO on this ground.
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2.3 Finally, the Ld. DRP followed the earlier order of Ld. DRP in assessment year 2012-13 and observed as under:- "Having considered the submissions, (For above 4 grounds), it is observed from the perusal of the TP order (in paragraphs 6 to 11) that the TPO has examined the issues raised above and recorded a detailed reasoning before making an adjustment on AMP expenditure. While deciding the issue, the TPO has discussed and considered the submissions made by the assessee. Before the DRP, the assessee has made similar submissions. We are in complete agreement with the conclusions drawn in para 10.8 of the TP order. However, considering the submissions of the assessee that routine expenditure has beer? treated as AMP by the TPO, we have sought Remand Report (RR) from the TPO after giving an opportunity to the assessee. After giving an opportunity to the assessee, the TPO submitted RR dated 06.12.2016; the relevant extract is reproduced below: "5. The TPO is of the view that there may be different forms of distribution channels adopted by tax payers wherein some companies may adopt direct selling of products to end customers (or) some companies may use retails chains to distribute end products to consumers. In the taxpayer's case, it has adopted the consignment model to distribute its products. Further, as per the website of M/s Parekh Integrated Solutions Ltd, it offers consignment services to various companies. This being the case, the taxpayer may have to provide required incentives to M/s Parekh Integrated Solutions Ltd to distribute its products, then that of its competitor's products. 6. Further, the warehousing & logistics function provided by M/s Parekh Integrated Solutions Ltd, does not result in any value addition of the taxpayer's products. On the other hand, facilities such cold storage/warehousing etc. are essentially required to maintain the composition of taxpayer's products, which are to be distributed. Therefore, such functions/Services are only incidental to the distribution function undertaken by M/s Parekh Integrated Solutions Ltd, for/on behalf of the taxpayer. Hence, the TPO has rightly considered the distribution commission paid as part of AMP expenses and therefore, it is requested that the Hon'ble DRP may kindly affirm the TPO's order."
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Considering the facts and circumstances of the case, and also considering the submissions of the assessee, we are of the view that the TPO for the detailed reasoning given therein is justified in his approach to make an adjustment on AMP. However, in respect of ground No 2, relating to distributors' commission, we are of the view that the cost relating to provision of warehousing, particularly the cold storage being provided by the distributors, needs to be excluded from the AMP. As per the Consignment Agency Agreement (CAG) entered by the assessee with M/s Parekh Integrated Services Pvt Ltd, Consignment Agent (CA), responsibility is cast on the CA by Clause 11 (a) to provide: (a) The CA shall provide work space equivalent to 500 square feet at the zonal offices and 300 square feet at other locations including two cabins for the zonal mangers of Alcon at the Zonal offices. It is agreed between the Parties that the area of the above work space(s) may be increased or decreased by Alcon as ....The work space provided at the zonal offices and other locations shall include telephone facilities and other accessories of an office premises including but not limited to chairs, tables. CA shall also provide table space with telephone facility for each of Alcon's Area Managers when visiting the CA's warehouses. The assessee is having distribution activities in 38 locations across India as per the submissions made by the assessee vide letter dated 25.01.2016. Further, the Warehousing charge is inbuilt in the distributor's commission and accordingly, we are of the view that an estimated cost of 25% of distributors' commission could be treated as towards the cost relating to provision of warehousing facility, which may be excluded for AMP purposes. Accordingly, we direct the AO to reduce 25% of the distributors' commission from the AMP. " 2.4 Consistent with the view taken by the Ld. DRP for 2012-13, Ld. DRP directed the AO to reduce 25% of the distributors' commission from the AMP. Against this assessee is in appeal before us. 3. We have heard the rival submissions and perused the materials available on record. In our opinion, this issue was considered by the Tribunal in assessee’s own case in assessment year 2012-13 in IT(TP)A No.726/Bang/2017 vide order dated 29.4.2022 and decided the issue in favour of the assessee by observing as under:-
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“9.1 The Ld.AR submitted that, the assessee purchases ophthalmic pharmaceuticals and ophthalmic surgical products from its AE is for distribution in India. It was submitted that assessee also renders services in relation to the products during and after warranty period. The Ld.AR submitted that, on one hand the revenue accepts the distribution activities and marketing activities carried on by assessee to be at arm’s length whereas on the other hand while making the AMP expenditure the Ld. TPO holds that the selling and distribution expenses incurred by assessee promotes the intangibles of AE in India and the distribution expenses incurred being towards the products amounts to advertisement. 9.2 The Ld.AR submitted that, the Ld. TPO did not consider that the sales promotion expenses and the seminars and conventions carried on ease to educate the Indian market in respect of the products distributor by the assessee within the Indian territory he submitted that by these expenditures the assessee is promoting its own business in India as a distributor. The details of the expenditure are as under:
9.3 The Ld.AR submitted that, the revenue made adverse observation that assessee incurred excessive sales and distribution expenses and compared to the comparable companies by using CUP as the most appropriate method. He submitted that the revenue has attributed excessive sales and distribution expenditure to the additional function of promoting and developing the marketing intangibles of the AE by assessee in India by using bright line test. It is the submission of the Ld.AR that, this is not a recognised method under the trans-uprising regulation.
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9.4 The Ld.AR submitted that, there is no agreement between the assessee and the AE to make such expenditure in order to promote the intangibles of the AE in India. And in the absence of any specific requirement to make such expenditure on behalf of AE, the expenditures incurred by assessee cannot be treated to be an international transaction. In support, he placed reliance on the decision of Hon’ble Delhi High Court in case of Maruti Suzuki India Ltd. vs. CIT, reported in 381 ITR 117 and M/s. Sony Ericsson Mobile Communications Pvt. Ltd. vs CIT reported in 374 ITR 118. 9.5 On the contrary the Ld. CIT.DR placed reliance on orders passed by authorities below. 9.6 We have perused submissions advanced by both sides in light of records placed before us. 9.7 We know that the DRP refused to follow the above decisions of Hon’ble Delhi High Court by observing that these decisions have not been accepted by the Department and SLP has been filed before Hon’ble Supreme Court. 9.8 It is not the case of the revenue that assessee is mandated to incur such expenditure as per any agreement between the assessee and a. It is also not disputed that these expenditures incurred by assessee or towards its own business promotion in India as assessee is a distributor further from the transfer pricing study report we note that assessee operates in limited risk environment in respect of the distribution and marketing segment. As per the TP study the description of activities carried on by the assessee that has been allegedly characterised by the Ld. TPO towards the promotion of brand are as under:
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9.9 On an identical situation, Coordinate Bench of this Tribunal in case of Essilor India Pvt. Ltd vs DCIT in IT(TP)A No 29/Bang/2014 and IT(TP)A No. 227/Bang/2015 observed and held as under: “12. We have heard the submissions of the learned counsel for the assessee as well as the ld. DR. The first aspect which was brought tour notice by the ld. counsel for the assessee is the decision of the ITAT in assessee's own case for assessment year 2009-10 and 2010- 11 on the same issue of AMP expenses. The Tribunal took the following view after extracting the decision of the Hon'ble Delhi High Court in the case of M/s Maruti Suzuki India Ltd. (supra). "21. Respectfully following the ratio of the decision of the Hon'ble Delhi High Court in the above cases, we hold that no TP adjustment can be made by deducing from the difference between AMP expenditure incurred by assessee-company and AMP expenditure of comparable entity, if there is no explicit arrangement between the assessee - company and its foreign AE for incurring such
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expenditure. The fact that the benefit of such AMP expenditure would also ensure to its foreign AE is not sufficient to infer existence of international trans action. The onus lies on the revenue to prove the existence of international transaction involving AMP expenditure between the assessee-company and its foreign AE. We also hold that that in the absence of machinery provisions to ascertain the price incurred by the assessee-company to promote the brand values of the products of the foreign entity, no TP adjustment can be made by invoking the provisions of Chapter X of the Act. 22.Applying the above legal position to the facts of the present case, it is not a case of revenue that there existed an arrangement and agreement between the assessee-company and its foreign AE to incur AMP expenditure to promote brand value of its products on behalf of the foreign AE, merely because the assessee-company incurred more expenditure on AMP compared to the expenditure incurred by comparable companies, it cannot be inferred that there existed international transaction between assessee-company and its foreign AE. Therefore, the question of determination of ALP on such transaction does not arise. However, the transaction of expenditure on AMP should 'co treated as a part of aggregate of bundle of transactions on which TNMM should be applied in order to determine the ALP of its transactions with its AE. In other words, the transaction of expenditure on AMP cannot be treated as a separate transaction. In the present case, we find from the TP study that the operating profit cost to the total operating cost was adopted as Profit Level Indicator which means that the AMP expenditure was not considered as a part of the operating cost. This goes to show that the AMP expenditure was not subsumed in the operating profitability of the assessee-company. Therefore, in order to determine the ALP of international transaction with its AE, it is sine qua non that the AMP expenditure should be considered a part of the operating cost Therefore, we restore the issue of determination of ALP, on the above lines, to the file of the AO/TPO. The grounds of appeal raised by the assessee-company on this issue are partly allowed."
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The ld. counsel for the assessee pointed out that none of the reasons given by the TPO in the order for assessment year 2013-14, for not following decision of the ITAT can be sustained. In this regard, the ld. counsel brought to our notice the facts which were highlighted by the assessee before the DRP. 16. We have given our careful consideration to the rival submissions. The Hon'ble Delhi High Court in the case of Maruti Suzuki India Ltd. (MSIL) v. Addl. CIT, TPO [2010] 328 ITR 210 (Delhi), in the case of a licensed manufacturer incurring AMP expenses it was held that it incurring of AMP expenses would be an international transaction and the issue of determination of ALP was remanded. This decision was however overruled in Maruti Suzuki India Ltd. v. Addl. CIT [2011] 335 ITR 121 (SC) wherein the Hon'ble Supreme Court left the question whether AMP expenses gives raise to international transaction or not open with the following observations: "In this case, the High Court has remitted the matter to the Transfer Pricing Officer ("the TPO" for short) with liberty to issue fresh show-cause notice. The High Court has further directed the Transfer Pricing Officer to decide the matter in accordance with law. Further, on going through the impugned judgment of the High Court dated July 1, 2010, we find that the High Court has not merely set aside the original show cause notice but it has made certain observations on the merits of the case and has given directions to the Transfer Pricing Officer, which virtually conclude the matter. In the circumstances, on that limited issue, we hereby direct the Transfer Pricing Officer, who, in the meantime, has already issued a show cause notice on September 16, 2010, to proceed with the matter in accordance with law uninfluenced by the observations/directions given by the High Court in the impugned judgment dated July 1, 2010. The Transfer Pricing Officer will decide this matter on or before December 31, 2010. The civil appeal is, accordingly, disposed of with no order as to costs."
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The Hon'ble Delhi High Court in an other case of Maruti Suzuki India Ltd. Vs. CIT 381 ITR 117 (Delhi) held that the fact that the benefit of such AMP expenses would also ensure to the AE is itself insufficient to infer the existence of an international transaction. Similar decision was also rendered by the Hon'ble Delhi High Court in the case of CIT (LTU) v. Whirlpool of India Ltd., 381 ITR 154. The bright line test which was applied by the AO in the present case was also applied by the AO in the aforesaid cases. The bright line test which was accepted by the Special Bench of ITAT in the case of L.G. Electronics India Pvt. Ltd. v. ACIT (2013) 22 ITR (Trib.) 1 (Del)(SB) was held by the Hon'ble Delhi High Court to be not correct. In the case of Maruti Suzuki (supra), the facts were Maruti Suzuki India Ltd. (MSIL) was engaged in the manufacture of passenger cars in India. It was a subsidiary of SMC, a Japanese company. MSIL started its business in 1982 as a Government of India owned company. SMC was selected as the business partner independently by MSIL. The co-branded trade mark "Maruti- Suzuki" was used since the inception of MSIL. A licence agreement was entered into between MSIL and SMC in October 1982 for its models M-800, Omni and Gypsy. By the agreement, MSIL was permitted to use the co-branded trade mark "Maruti- Suzuki" on the vehicles. In the assessment of MSIL for assessment year 2005-06, the AO invoked the provisions of section 92CA(1) of the Act and referred the case to the Transfer Pricing Officer for determination of the arm's length price in relation to the international transactions undertaken by MSIL with its associated enterprise, SMC. The Transfer Pricing Officer passed an order making an adjustment of Rs. 154.12 crores towards the advertisement, marketing and sales promotion expenses imputing a notional arm's length compensation towards the advertisement, marketing and sales promotion expenses incurred by MSIL for SMC. On the above facts, the Hon'ble Delhi High Court held as follows: ".... when the licence agreements were originally entered into in 1982, MSIL was known as MUL and SMC did not hold a single share in MUL. In 2003 SMC acquired the controlling interest in MSIL. There were various models of Suzuki motor cars manufactured by MSIL and each model was covered by a separate licence agreement. Under these agreements, granted licence to MSIL to manufacture that particular car model and provided technical know-how and information and right to use Suzuki's
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patents and technical information. It also gave MSIL the right to use Suzuki's trade mark and logo on the product. Pursuant to this agreement, MSIL was using the co-brand, i.e., Maruti Suzuki trade mark and logo for more than 30 years. This cobrand could not be used by SMC and was not owned by it. The clauses in the agreement between MSIL and SMC indicated that permission was granted by SMC to MSIL to use the co- brand "Maruti Suzuki" name and logo. The mere fact that the cars manufactured by MSIL bore the symbol "S" was not decisive as the advertisements were of a particular model of the car with the logo "Maruti- Suzuki". The Revenue had been unable to contradict the submission of MSIL that the co-brand mark "Maruti-Suzuki" in fact did not belong to SMC and could not be used by SMC either in India or anywhere else. The decision in the case of Sony Ericsson requires that the mark or brand should belong to the foreign associated enterprise. The Revenue also did not deny that as far as the brand "Suzuki" was concerned its legal ownership vested with the foreign associated enterprise, i.e., SMC. Moreover as MSIL was concerned, its operating profit margin was 11.19 per cent. which was higher than that of the comparable companies whose profit margin was 4.04 per cent. Therefore, applying the transactional net margin method it must be stated that there was no question of a transfer pricing adjustment on account of advertisement, marketing and sales promotion expenditure. The advertisement, marketing and sales promotion expenses incurred by MSIL could not be treated and categorised as an international transaction under section 92B of the Act." 18. In the case of Whirlpool of India Ltd. (supra), it was held that there had to be an international transaction with a certain disclosed price. The transfer pricing adjustment envisages the substitution of the price of such international transaction with the arm's length price. The transfer pricing adjustment was not expected to be made by deducing from the difference between the excessive advertising, marketing and sales promotion expenditure incurred by the assessee and the advertising, marketing and sales promotion expenditure of a comparable entity that an international transaction existed and then proceeding to make the adjustment of the difference in order to determine the value of such advertising, marketing and sales promotion expenditure incurred for the associated enterprise. Thus, the bright line test had been rejected as a valid method for either determining the existence of an international transaction or for the
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determination of the arm's length price of such transaction. Although under section 92B read with section 92F(v), an international transaction could include an arrangement, understanding or action in concert, this could not be a matter of inference. There had to be some tangible evidence on record to show that two parties had acted in concert. It was also held that the provisions under Chapter X envisaged a separate entity concept. In other words, there could not be a presumption that the assessee was a subsidiary of the foreign company and that all the activities of the assessee were in fact dictated by the foreign company. Merely because the foreign company had a financial interest, it could not be presumed that advertising, marketing and sales promotion expenses incurred by the assessee were at the instance or on behalf of the foreign company. The initial onus was on the Revenue to demonstrate through some tangible material that the two parties acted in concert and further that there was an agreement to enter into an international transaction concerning advertising, marketing and sales promotion expenses." 19. In the light of the law as it exists today, we shall examine the arguments of the rival parties. There has been no agreement between Essilor International which owns the various brands set out by the TPO in his order and the Assessee to incur any Advertisement and Marketing or Sales promotion expenses. None of the other reasons given by the TPO which have been explained by the Assessee and set out in the earlier paragraph can be the basis to hold that there was in fact an international transaction in the matter of incurring of AMP expenses by the Assessee. The order of the Tribunal in Assessee's own case for A.Y.2009-10 and 2010-11 in our view requires to be followed and there are no reasons whatsoever to take a different view. Consequently, there could not be any exercise of determining the ALP of the AMP expenses by comparing the expenses incurred by the Assessee with comparable companies. In view of the above conclusions, the other aspects whether the comparable companies chosen by the TPO are in fact comparable in terms of Functions performed, Assets employed and Risks assumed (FAR) analysis and other aspects of determination of ALP does not require any consideration. Therefore the addition made on account of determination of ALP of AMP expenses in AY 2011-12 to 2014- 15 is directed to be deleted.”
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In our view the above view by the coordinate bench requires to be followed, and there are no reasons whatsoever to take a different view. Respectfully following the above view, we redirect the Ld.AO/TPO to delete the addition made towards AMP expenses. 3.1 In view of the above order of the Tribunal, taking a consistent view, we allow these grounds taken by the assessee in both the appeals for the assessment years 2013-14 & 2014-15.” 8. The facts being identical in the year consideration respectfully following the above decision, we direct the AO/TPO to delete the addition made towards ALP determined for AMP expenses.
TP adjustment in IT support services - Ground Nos.21 to 30
The assessee has declared a margin of 13.04% in the IT service segment as computed below:-
Particulars IT Support Services Sales 17,39,31,132 15,12,44,463 Les: Direct expenses 2,26,86,669 Operating Profit 13.04% Operating margin
The assessee is applying Transactional Net Margin Method (TNMM) as the most appropriate method for the purpose of computing the arm’s length margin. Operating profit/Operating Cost ratio has been taken as the Profit Level Indicator. The AO did not accept the comparables selected by the assessee. The TPO by applying fresh filters chose the final set of comparables as given below:-
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Sl. Company Name Financial Year Wise OP/OC (%) No. 2015-16 2014-15 2013-14 Average
Kals Information Systems Pvt. Ltd. 4.33 5.77 16.94 8.73 2. Rheal Software Pvt. Ltd. 3.29 3.02 36.38 14.54 3. CG-VAK Software & Exports Ltd. 20.16 19.87 13.91 18.05 4. Inteq Software Pvt, Ltd. 7.64 32.95 45.36 20.47 5. R S Software (India) Ltd. -1.98 32.66 24.14 20.87
Larsen & Toubro Infotech Ltd. 21.12 23.07 6. 24.24 22.69 7. Nihilent Ltd. 15.94 29.19 33.12 25.64 8. Persistent Systems Ltd. 23.95 30.4 35.1 29.25
Infobeans Technologies Ltd. 35.19 20.92 42.6 32.71
Aspire Systems (India) Pvt. Ltd. 30.45 37.21 33.55 33.63
Infosys Ltd. 38.62 41.38 36.16 38.74
30.18 42.46 48.17 39.86 12 Thirdware Solutions Ltd.
13 Cybage Software Pvt. Ltd. 62.06 68.3 68.97 66.03
35th percentile 20.87 Median 25.64 65th Percentile 32.71
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Accordingly the TPO arrived at the TP adjustment as given below:-
Formula Amount (in Rs.) Particulars Taxpayers operating revenue OR 17,39,31,132 Taxpayers operating cost UDC 15,12,44,40 Taxpayers operating profit OP 2,26,86,669 Taxpayers PLI OP/OC 15.00% 35th Percentile Margin of comparable set 20.87%. Adjustment Required (if PLI < 35th Yes Percentile) Median Margin of comparable set M 25.64% ALP = Arm's Length Price 19,00,23,543 (1+M)*OC Price Received OR 17,39,31,132 Shortfall being adjustment ALP-OR 1,60,92.411
The final list of comparable after the DRP directions are as below:-
Inteq Software P. Ltd. 2. R S Software India ltd. 3. L&T Infotech Ltd. 4. Nihilent Ltd. 5. Persistent Systems Ltd. 6. Infobeans Technologies Ltd. 7. Aspire Systems India P. Ltd. 8. Infosys Ltd. 9. Thirdware Solutions Ltd. 10. Cybage Software P. Ltd.
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The ld. AR submitted that out of the above listed comparables, except for item No.1 & 6, the rest of the comparables have to be excluded based on the application of upper turnover filter. The ld. AR submitted that the turnover of the assessee is Rs.17 crores. The TPO while applying the turnover filter applied only the lower turnover filter of Rs.1 crore but did not apply the higher turnover filter of Rs.200. Accordingly, the ld. AR prayed for the exclusion of these comparables.
We heard the rival submissions. The Tribunal in the case of Autodesk India Pvt. Ltd. Vs. DCIT (2018) 96 Taxmann.com 263 (Bangalore-Tribunal), took note of all the conflicting decision on the issue and rendered its decision and in paragraph 17.7. of the decision held as that high turnover is a ground for excluding companies as not comparable with a company that has low turnover. The following were the relevant observations:
17.7. We have considered the rival submissions. The substantial question of law (Question No.1 to 3) which was framed by the Hon'ble Delhi High Court in the case of Chryscapital Investment Advisors (India) Pvt.Ltd., (supra) was as to whether comparable can be rejected on the ground that they have exceptionally high profit margins or fluctuation profit margins, as compared to the Assessee in transfer pricing analysis. Therefore as rightly submitted by the learned counsel for the Assessee the observations of the Hon'ble High Court, in so far as it refers to turnover, were in the nature of obiter dictum. Judicial discipline requires that the Tribunal should follow the decision of a non-jurisdiction High Court, even though the said decision is of a non- jurisdictional High Court. We however find that the Hon'ble Bombay High Court in the case of CIT Vs. Pentair Water India Pvt.Ltd. Tax Appeal No.18 of 2015 judgment dated 16.9.2015 has taken the view that turnover is a relevant criterion for choosing companies as comparable companies in determination of ALP in transfer pricing cases. There is no decision of the jurisdictional High Court on this
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issue. In the circumstances, following the principle that where two views are available on an issue, the view favourable to the Assessee has to be adopted, we respectfully follow the view of the Hon'ble Bombay High Court on the issue. Respectfully following the aforesaid decision, we uphold the order of the DRP excluding 5 companies from the list of comparable companies chosen by the TPO on the basis that the 5 companies turnover was much higher compared to that the Assessee. 17.8. In view of the above conclusion, there may not be any necessity to examine as to whether the decision rendered in the case of Genisys Integrating (supra) by the ITAT Bangalore Bench should continue to be followed. Since arguments were advanced on the correctness of the decisions rendered by the ITAT Mumbai and Bangalore Benches taking a view contrary to that taken in the case of Genisys Integrating (supra), we proceed to examine the said issue also. On this issue, the first aspect which we notice is that the decision rendered in the case of Genisys Integrating (supra) was the earliest decision rendered on the issue of comparability of companies on the basis of turnover in Transfer Pricing cases. The decision was rendered as early as 5.8.2011. The decisions rendered by the ITAT Mumbai Benches cited by the learned DR before us in the case of Willis Processing Services (supra) and Capegemini India Pvt.Ltd. (supra) are to be regarded as per incurium as these decisions ignore a binding co-ordinate bench decision. In this regard the decisions referred to by the learned counsel for the Assessee supports the plea of the learned counsel for the Assessee. The decisions rendered in the case of M/S.NTT Data (supra), Societe Generale Global Solutions (supra) and LSI Technologies (supra) were rendered later in point of time. Those decisions follow the ratio laid down in Willis Processing Services (supra) and have to be regarded as per incurium. These three decisions also place reliance on the decision of the Hon’ble Delhi High Court in the case of Chriscapital Investment (supra). We have already held that the decision rendered in the case of Chriscapital Investment (supra) is obiter dicta and that the ratio decidendi laid down by the Hon’ble Bombay High Court in the case of Pentair (supra) which is favourable to the Assessee has to be followed. Therefore, the decisions cited by the learned DR before us cannot be the basis to hold that high turnover is not relevant criteria for deciding on comparability of companies in determination of ALP under the Transfer Pricing regulations under the Act. For the reasons given above, we uphold the order of the CIT(A) on the issue of application of turnover filter and his action in excluding companies by following the ratio laid down in the case of Genisys Integrating (supra).
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In view of the aforesaid decision, we hold that companies listed whose turnover in the current year is more than Rs.200 Crores should be excluded from the list of comparable companies.
Exclusion of Inteq Software
The TPO held that the company is engaged in software development and therefore should be added as comparable. The DRP upheld the inclusion on the ground that the principle activity of the company is software development services and that the company satisfies various filters adopted by the TPO.
The ld. AR submitted that the company offers solutions which are in the nature of application development which involves providing full life cycle support that starts from requirement gathering phase and lasts till maintenance, trading of software products, software validation and a wide range of healthcare BPO services. The ld. AR submitted that in the annual report of the company, no segmental break-up is available nor does the revenue break-up towards various activities undertaken by the company is available. It is therefore contended that the company is to be excluded.
Infobean Technologies Ltd.
The company is included by the TPO on the ground that it is functionally comparable and is purely into software development. The DRP upheld the inclusion by stating that the company is a service company primarily rendering software services and the operational
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revenue stream is entirely from software services. The DRP also held that the high profitability criteria cannot be considered for exclusion since the company is found to be functionally comparable in terms of Rule 10B.
The ld. AR submitted that the company is engaged in custom application development, content management system, enterprise mobility and big data analytics (pg. 1947 & 1980 of PB-II). As per the company’s website, it is entrepreneurial entity engaged in providing custom development services to offshore clients. Further it provides software engineering services primarily in custom application development, content management, etc. which are classified as high end services that are not comparable to the functions of the assessee. The ld. AR also submitted that the company has made significant investment in technology absorption. It is also submitted that the growth in the revenue of the company has been significant during the year under consideration whereby there is a 76% growth in the revenue and 147% increase in the profit after tax which clearly demonstrates that the company has undergone abnormal year of operations during AY 2016-17.
The ld. AR further relied on the decision of Finastra Software Solutions India P. Ltd. v. DCIT, IT(TP)A No.268/Bang/2021 dated 28.11.2022 with regard to the exclusion of the above two companies.
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We notice that the coordinate Bench in the case of Finastra Software Solutions (supra) has considered the exclusion of Inteq Software and Infobean Technologies and held that –
“ 21. We have heard the rival contentions and perused the material on record. We notice that the coordinate bench in the case of NTT Data FA Insurance Systems (India) Pvt. Ltd (supra) has considered the issue of exclusion of Inteq Software Pvt. Ltd. and Infobeans Technologies Ltd. and held as under: - “18. We have heard the rival submissions and perused the materials available on record. In our opinion, this comparable was considered by the Hyderabad Tribunal in the case of ADP Pvt. Ltd. in ITA No.227 & 228/Hyd/2021 dated 3.2.2022 at para 7 page 3678 to 3680 wherein held as under:- 7. “Infobeans Technologies Ltd.: The ld. AR of the assessee submitted that this company is functionally different for the following reasons: 1. It is engaged in diversified activities in the nature of custom application development, content management systems, enterprise mobility, big data analytics, 2. No change in the business as compared to last year 3. Leading provider of consulting technology & next generation service. 4. There is abnormal increase in percentage of revenue from 35.35 crore to 62.06 crore. 5. It is also into IT enabled services i.e. business process management, HR and Payroll, commerce 6. No segmental details are available. 7.1 He relied on various decisions of ITAT including the decision in ITA No. 2233/Hyd/2018 for AY 2014-15 wherein this company is excluded as comparable. 7.2 The Ld. DR, on the other hand, submitted that this company is engaged in rendering of software services and, hence, functionally comparable to assessee company. 7.3 We have considered the rival submissions and perused the material on record as well as gone through the orders of revenue authorities. The
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coordinate bench of this Tribunal in ITA No. 2233/Hyd/2018 for AY 2014-15, directed the AO/TPO to exclude this company from the list of comparables for determining ALP by observing as under: 21. Having regard to the rival contentions and the material on record, we find that the Coordinate Bench of the Tribunal in the following case has considered similar objections of the assessee therein to direct exclusion of this company from the final list of comparables. For the purpose of ready reference, the relevant paragraph is reproduced below: "18. We have heard the rival contentions and perused the record. The first aspect is the functional comparability of concern which has been finally selected to be comparable. In respect of Infobeans Systems Pvt. Ltd., the financials of said concern clearly reflect that in addition to providing software development services to its associated enterprises, it had also earned foreign exchange from export of goods on FOB basis. The event of export of goods was also mentioned in notes and also in the Profit and Loss Account, where revenue from sale of software was declared. The segmental details of two activities carried on by the said concern were not available and in the absence of the same, the concern could not be equated as functionally comparable to a concern which was providing software development services to its associated enterprises. Applying the same set of reasoning as in the paras hereinabove, we hold that Infobeans Systems Pvt. Ltd. is not comparable to the assessee". 22. Respectfully following the same, we direct that Infobeans be excluded from the final list of comparables in this case also. 7.4 On perusal of the order of the coordinate bench of this Tribunal and on perusal of the financial statements of Infobeans Technologies Ltd., we observe that the company is functionally not comparable and no segmental details are available. Therefore, the coordinate bench did not consider this company as comparable in assessee’s own case for AYs 2014-15 & 2015-16. Respectfully following the decision of the coordinate bench, we direct the AO/TPO to exclude this company from the final list of comparables.” IT(TP)A No.261/Bang/2021 NTT Data FA Insurance Systems (India) Pvt. Ltd., Bangalore Page 21 of 37 18.1 Same view was taken by the Tribunal in the case of Global Logic India Pvt. Ltd. Vs. DCIT reported in (2022) 134 Taxmann.com 35 for the assessment year 2016-17. Respectfully following above judgement,
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we are inclined to direct the AO/TPO to exclude this company from the list of comparables.” 19.**** 20.**** 21. We have heard the rival submissions and perused the materials available on record. This comparable has considered in the case of Global Logic India Pvt. Ltd. Vs. DCIT (2022) 134 Taxmann.com 35 for the assessment year 2016-17, wherein held as under:- 46. “The taxpayer sought exclusion of Inteq again on account of functional dissimilarity being into providing outsourced product development services and Healthcare BPO services to its customers as per website extracted at pages 83 to 85 of the appeal memo set. It being a private limited company its financials are not available in the public domain. Its annual report made available at pages 848 to 909 of the annual reports paper book does not provide segmental profitability earned from software development services, outsourced product development services and Healthcare BPO services. 47. When we examine profit & loss account at page 873 of the annual report paper book, software development and service charges are shown in composite manner with no segmental profitability. In these circumstances, we are of the considered view that Inteq is not a suitable comparable vis-a-vis the taxpayer which is a routine software development service provider working on costplus mark up model, hence ordered to be excluded from the final set of comparables.” 21.1 In view of the above order of the Tribunal, we direct the AO/TPO to exclude this company from the list of comparables. 22. Respectfully following the decision of the coordinate bench we hold that Inteq Software Pvt. Ltd and Infobeans Technologies Ltd., be excluded from the list of comparables.”
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Respectfully following the decision of the coordinate bench we hold that Inteq Software Pvt. Ltd and Infobeans Technologies Ltd., be excluded from the list of comparables.
Disallowance of seminars, conventions and sales promotion expenses – Ground no.31 23. The AO during the course of assessment issued a notice u/s. 142(1) dated 28.11.2019 asking the assessee to provide the breakup of seminar and convention expenditure amounting to Rs.16,30,03,645 along with details of TDS applicability and deductions made party wise. After considering the submissions, the AO noticed that the assessee has incurred an expenditure of Rs.1,58,88,337 against travel and stay and other charges. The assessee submitted that these expenses are incurred towards making Doctors & Patients aware of the working and performance of its products and therefore these expenses are claimed as having a direct nexus to the business of the assessee. The AO did not accept the submissions and disallowed the expenditure by stating as under:-
“However, the nature of these expenses are prohibited by law. These expenses are prohibited by regulation 6.4.1 of the Indian Medical Council (Professional conduct, Etiquette and Ethics) Regulations. 2002 which existed during the assessment year 2013-14 which created bar on the physicians on receiving gifts gratuities, commissions or bonus in consideration of or return for the referring, recommending or procuring of any patients for medical, surgical or other treatment. The expenditure has been admittedly incurred by the assessee with an objective to encourage doctors to recommend their optical -items and pharmaceutical products dealt within by the assessee to the patients. so that sales and profitability of the assessee company increases which
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clearly reflect that these are legal gratification which are prohibited by law. The CBDT brought a Circular No. 5 of 2012 dated 1-8-2012 which is clarificatory and clarifies that any expenses incurred in violation of the provisions of Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations. 2002 shall be inadmissible under section 37(1) being an expense prohibited by the law. The law as stood during relevant previous year as per provisions of section 37(1) read with explanation inserted by Finance Act, 1998 with effect from 1-4- 1962 clearly stipulates that if an expenditure is incurred for any purpose which is an offence or which is prohibited under law shall not be allowed as deduction due to restriction contained under section 37(1) read with explanation. The said circular dated 1-8-2012 issued by the CBDT was subject to challenge in writ petition filed in Himachal Pradesh High Court in the case of Confederation of Pharmaceutical Industry v. CBDT writ petition No. 10793 of 2012-J wherein validity of the said CBDT circular was challenged, the Himachal Pradesh High Court held that the said circular is valid and the Indian Medical Council (Professional Conduct. Etiquette and Ethics) Regulations, 2002 governing professional ethics of Doctors issued is salutary which is in the interest of public and patient. The Punjab and Haryana High Court has vide decision In CIT vs. M/s. Kap Scan and Diagnostic Centre (P.) Ltd. (2012) 25 taxmann.com 92/344 ITR 476 has confirmed disallowance of commission as not allowable under section 37(1) being against public policy prohibited by law. Based on factual matrix of the case as emerging from the records, the travel expenses incurred by the assessee company were in the form of seminar and conventions which bears the cost of doctors to undertake foreign tours in the guise of seminars and conferences and sales promotion expenses which includes various facilities provided by the company to doctors. These expenses are directly hit by Explanation to section 37. It is well accepted and settled proposition that regulations are covered under the definition of law'. The definition in General Clauses Act, 1897 defines 'Indian law under section 3(29) to mean any Act, Ordinance, Regulation, Me, order, bye-law or other instrument which before the commencement of the Constitution had the force of law in any Province of India or part thereof, or thereafter has the force of law In arty Part A State or Part C State or Part thereof but does not include any Act of Parliament of the United Kingdom or any Order in Council,
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rule or other instrument made under such Act. Similarly, under Constitution of India the word law' in context of fundamental rights is defined under article 13(3)(a) and includes any ordinance, order, bye- law, rule, regulation, notification, custom or usage having in the territory of India the force of law. Thus, the Indian Medical Council (Professional conduct. Etiquette arid Ethics) Regulations, 2002 has force of law as it was promulgated in exercise of the powers conferred under section 20A read with section 33(m) of the Indian Medical Council Act, 1956 (102 of 1956), the Medical Council of India, with the previous approval of the Central Government, made the regulations relating to the Professional Conduct, Etiquette and Ethics for registered medical practitioners, namely the Indian Medical Council (Professional conduct, Etiquette and Ethics) Regulations, 2002 and hence these regulations shall be covered under the definition of law' and hence is covered under explanation to section 37. For claiming the expenses under section 37 which is a residuary sector', it is essential that the expenses are not covered under clauses of Sections 30 to 36 and are incurred wholly and exclusive for the purposes of business and it is not sufficient that it has some connection with the business of the assessee. Reliance is placed on the decision of Hon'ble ITAT !shortie in the case of ACIT vs. M/s. Live Healthcare Ltd dated September 12, 2016, [2016) 181 TTJ 433 (Mumbai Trib.) which squarely covers the facts of the case. 3.3 Out of expenses towards Seminar and Convention expenses and Sales promotion expenses, the expenditure incurred by the assessee company towards travel and stay charges amounts to Rs.1,58,88,337/- respectively. These expenses are construed as freebies given to doctors, Therefore in ins with the discussions made. these expenses are disallowed under section 37 of the IT Act.” 24. The DRP upheld the disallowance by stating that –
“As the MCI regulations are towards promoting a public interest, a narrow and pedantic view contrary to public interest and objectives of the regulation cannot be taken. The validity of the regulation has been already upheld by the courts. In the light of the above, the proposed disallowance is upheld.”
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The Ld. AR submitted that the AO has accepted the honorarium paid to the Doctors whereas he as disallowed the travel expenses. The ld. AR also submitted that these expenses are not freebies given to the Doctors, but are incurred towards making the Doctors aware of the performance of the products of the assessee, who use these products in surgeries. The ld. AR further submitted that all the relevant details and supporting with regard to these expenses are already submitted before the AO which would substantiate the claim of the assessee.
The ld DR relied on the order of the lower authorities.
We have heard rival submissions and perused the material on record. It is pertinent to note that prior to the judgment of the Hon’ble Apex Court in the case of M/s. Apex Laboratories Pvt. Ltd. v. DCIT [2022] 135 taxmann.com 286 (SC) many of the judicial pronouncements had held that MCI Regulations are not applicable on pharmaceutical companies and expenses incurred by such companies are not violative of CBDT Circular. During this phase of assessment, there were only adhoc summary basis evaluation of expenditure. In the present case also there is no critical evaluation of the expenses and post the Hon’ble Supreme Court judgment, the dictum laid down, same needs to be followed and each of the expenditure needs to be evaluated to see if the disallowance is justified. It was claimed that even if the criteria as laid down in CBDT Circular and also the MCI Regulation (as now affirmed by the Hon’ble Apex Court is applied), the expenditure incurred towards contractual obligation with Doctors and
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employees of pharmaceutical companies does not call for disallowance. In the present case, the A.O. had primarily made disallowance by referring the CBDT Circular No.5/2012 dated 01.08.2012. In the larger interest of justice, in view of the latest judgment of the Hon’ble Apex Court, which has examined the very same issue, it becomes necessary to examine the exact nature of expenses incurred by the assessee for Doctors from all angles. Therefore, for substantial question and cause, necessarily, the matter needs fresh verification by the A.O., especially in the light of the recent judgment of the Hon’ble Supreme Court in the case of M/s. Apex Laboratories Pvt. Ltd. v. DCIT (supra). For the aforesaid purpose, the issues is remitted back to the AO to examine the details submitted in the light of the decision of the Apex Court after giving an opportunity of being heard to the assessee. It is ordered accordingly.
Ground no.32 and 33 are consequential and does not warrant separate adjudication.
In the result, the appeal by the assessee is partly allowed.
Pronounced in the open court on this 19th day of December, 2022.
Sd/- Sd/-
( N V VASUDEVAN ) ( PADMAVATHY S ) VICE PRESIDENT ACCOUNTANT MEMBER Bangalore, Dated, the 19th December, 2022. /Desai S Murthy /
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Copy to:
Appellant 2. Respondent 3. CIT 4. CIT(A) 5. DR, ITAT, Bangalore.
By order
Assistant Registrar ITAT, Bangalore.